Private Debt and How It Benefits Investors
The private debt landscape represents exciting opportunities for Australian investors. Offering the potential for regular income and capital preservation, private debt (also known as private credit) is an increasingly accessible avenue for investors looking to diversify their portfolios.
What is Private Debt?
Private debt refers to loans made outside of the traditional banking system. Instead, loans are made directly to borrowers by private debt investors – often in the context of commercial real estate or business loans. For lenders, a return on the investment is made in the form of regular loan and fee repayments.
This structure can be attractive to borrowers in helping to secure a loan where banks or institutional lenders may be unable or unwilling. For investors, private credit funds offer the potential for a stable, income-generating investment, with interest and fee payments from borrowers arriving at regular intervals, as well as other advantages including capital stability, portfolio diversity and a resistance to inflationary pressures.
Reliable Income Generation
One of the most appealing aspects of private credit investing is the ability to generate regular income, even across periods of volatility. For investors, income is tied to regular interest and fee repayments, which are received at fixed intervals.
With a well-negotiated debt investment, investors should receive regular income injections for the life of the investment, with outcomes generally not tied to other market forces. Conservative funds might see returns of around 7-8%, while high-yield funds can often achieve returns of up to 12%.
Comparing Private Debt and Dividends
For investors, having a regular source of income can be one of the great advantages of private debt. The way this functions – with a floating base rate keeping income in line with inflation – means that many investors find private debt an appealing alternative to traditional dividend income.
Dividends are not guaranteed to shareholders and can be at the mercy of market forces, with periods of upheaval (such as during the pandemic) sometimes resulting in companies suspending dividends. Private debt, on the other hand, tends to retain a steady income stream regardless of the market.
Capital Stability and Preservation
Capital preservation (in which the original investment is protected) is a great attraction for investors when considering private debt. One function of Australian corporate insolvency laws, for example, gives preference to creditors/debt over equity. This means there is less risk of capital loss with private debt than there is with equity.
Other factors of private debt that contribute to relative stability include borrower security against the loan and other entrenched protections which have kept corporate loan losses low in recent history.
Diversification Benefits
Unlike many other investment classes, private debt has little correlation with the forces of the market and, as such, tends to act relatively consistently in all financial weather. This makes private debt a strong candidate for a diverse portfolio, offering regular income (as mentioned above) while avoiding capital volatility.
Low Correlation with Traditional Assets
Asset classes such as bonds and equities are not strongly correlated with private debt. For investors looking to diversify their portfolio or to avoid the traps of traditional asset classes (such as vulnerability to a volatile market), private debt can represent a good option.
Protection Against Inflation
Inflation can be the enemy of a fruitful investment portfolio, with rising costs and prices having the power to reduce overall returns. Private debt investments, however, tend to resist inflationary pressure. This feature of private debt is due to the fact that investment returns are generated through loan fees and repayments, which are generally tied to floating rates – often a margin above the Bank Bill Swap Rate (BBSW). Because of this, private debt can resist the inflationary environment that causes increased interest rates, with investment income rising alongside rates.
Who should Consider Private Debt Investments?
As mentioned, private debt investments are unique propositions for investment portfolios. While no single investment type is right for everyone, private debt should be considered by those looking to find investments which resist market volatility, provide regular income, and which offer strategic diversification.
How to Get Started with Private Debt Investing
Looking to invest in private debt?
Here’s how to get started:
- What’s private credit? Do your research first: While private debt has many positives, past performance is never an indication of future performance, and individual funds and investments should always be thoroughly understood before you make a financial commitment.
- Make sure it’s right for you: Private debt is a strong investment for many reasons, but it is not right for everyone. A good place to start is to figure out your investment goals and objectives, and make sure that private debt aligns with these.
- Speak with the experts: Enlisting the expertise of dedicated private debt fund managers is a valuable step in ensuring you get the best result for your investment. We would recommend speaking with one of our fund managers at Melbourne Finance and Equity Group to assess the suitability of private debt for you.
FAQs About Private Debt Investments
What are the Typical Returns on Private Debt Investments?
While past performance is not an indication of future performance, many private debt investments retain consistent rates of return. For more conservative funds, we see returns of 7-8%, while high-yield debt funds can regularly achieve returns of up to 12%.
How does Private Debt compare to other Fixed-Income Investments?
Besides the rates of return, private debt has favourable comparisons with many other fixed-income investments. Particularly, private debt tends to be less volatile than traditional asset types. Private debt can also be more reliable in generating income than other asset classes.
What are the Risks associated with Private Debt Investing?
All investment includes risk and private debt is no different. Risks can include debtors defaulting and / or being unable to service the loan, though it should be noted that insolvency laws place the highest priority on repaying creditors – i.e., private debt investors. This means that risk is balanced against robust legal protections, making private debt a strong investment for those favouring capital preservation.
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